(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2025--collected through our interactions with investors and other market participants. The series is aligned with the key themes we're watching in the coming year and is part of our Global Credit Outlook 2025.)
Since the significant speed and extent of data center growth have taken many by surprise, there are only a few plans in place to provide the physical infrastructure that these power-hungry assets require. We expect sectors exposed to data centers will continue to benefit from favorable tailwinds in 2025. After that, pressure could likely increase as bottlenecks materialize.
How This Will Shape 2025
Growth potential in the data center sector is significant. Advances in artificial intelligence (AI), 5G adoption, and cloud services increase the demand for data centers, whose numbers and growth rates are highest in the U.S. This is notably due to the country's high concentration of major technology companies, which invest heavily in capacity expansion to support their global operations. The AI revolution constitutes an exceptional growth opportunity for the technology sector. We forecast that global AI-related revenues will increase at a compound annual growth rate (CAGR) of about 25%-30% to nearly $650 billion by 2028, from less than $200 billion in 2023. This is a global trend: In South Asia and Southeast Asia, for instance, we anticipate that data center capacity will increase at a CAGR of 10%-25% over the next few years, spurring investments and funding opportunities.
Chart 1
The increase in the number and capacity of data centers requires ample physical infrastructure. For 2025-2030, we expect U.S. data centers could require 150 to 250 terawatt hours annually, which is equivalent to the power demands of New York City. The speed and extent of data center growth have taken a significant portion of the market by surprise, meaning there are few plans in place to accommodate it. After two decades of stagnating power demand, insufficient grid infrastructure--which results in long interconnection queues--will likely be the biggest hurdle to meeting data centers' energy needs. In our base case for the U.S., we assume that the increase in annual electricity sales will not cover the technology industry's electricity needs after 2026.
The surge in data centers will increase funding requirements in 2025. Given the pace and extent of capital deployment required, careful and consistent funding will be key to support data center operators' credit quality. Private credit has emerged as a more prominent financing source for data centers since it provides flexible capital solutions that support the rapid growth and technological advancements in this asset class. In some markets, sustainability-linked or green bonds could play an increasingly important role, notably to fund green initiatives that aim to increase energy efficiency or provide renewable energy solutions.
Chart 2
What We Think And Why
Data center developers and operators will benefit from the demand for new facilities and support high rental prices. We expect the leasing environment for data centers will remain strong in 2025. This should result in positive re-leasing spreads and low vacancy rates. We expect strong demand, limited near-term supply, and improved pricing dynamics will bolster data centers' earnings and valuations, at least over the next few years. The location of data centers, similar to other real estate assets, is critical for their valuations. Tier 1 assets, which are interconnected and have access to reliable power supplies, will likely continue to benefit the most.
Positive credit developments will likely offset credit challenges in the energy sector in 2025. The surge in the number and capacity of data centers will support credit quality in 2025 for sectors exposed to the trend, including power generators, electricity utilities, and midstream gas companies. In an already tight power market, additional demand will result in tighter supply and higher power prices through 2030. We believe this trend will support earnings growth and visibility for all power generators--particularly green power generators--due to the increase in long-term contracts. We view this as credit positive for companies operating in the competitive power markets. Additionally, data centers' increased electricity demand will support regulated utilities' credit quality. That said, the rising electricity demand could introduce funding and billing risks, which utilities will have to consider to protect existing clients from cost increases.
Data centers provide an additional lifeline for gas and nuclear assets. Low-risk gas projects with manageable capital expenditures will likely meet the rapid growth in data centers' energy demands over the near term, despite long-term decarbonization trends. Additional electricity demand from data centers will hence spur supply growth over the next decade and support credit quality in the gas midstream sector. Over the longer term, we expect nuclear power will potentially provide a low-carbon, reliable solution to power data centers. Consequently, financing needs for new projects--notably for small nuclear reactors--could increase in 2025.
What Could Change
Increasing risk appetite could curb real estate companies' overall credit profiles. Real estate companies remain exposed to development risks. So far, the sector has been prudent, with fit-for-purpose, pre-leased new builds and a limited risk of overbuilding over the next two years. Yet more speculative development approaches and risks related to unmanaged power price exposures could emerge and increase credit risk considerably. If demand for data centers declines due to slower AI adoption, vacancy rates could increase significantly, notably for tier 2 assets. Prudent expansion will also be key in emerging markets due to evolving regulations, interconnectivity issues, and insufficient power supply infrastructure in these regions.
Inflation and increasing financing needs could become a bigger challenge. Data center construction costs could increase substantially due to expenses related to construction, inflation, and financing. Rental rates and construction costs do not necessarily increase in tandem, even though they did so over the past two years. Data centers' inability to cover rising construction costs by increasing rental rates could derail growth prospects. Utilities will also have to increase capital spending considerably to meet the demands of relatively few, but very large, data center customers. Simply passing on a significant portion of these infrastructure costs to existing residential customers would increase customer bills, lead to more complaints, and potentially impair utilities' ability to manage regulatory risk.
Environmental constraints may rise. Despite securing renewable energy supply and improving efficiencies, data centers could nearly double their emissions by 2030. These projected increased carbon emissions are unlikely to pose a material credit risk to operators in 2025, given their key role in supporting AI-based technologies and economic growth. Yet data centers could face several headwinds since their power use will rapidly expand. We expect continuous improvements in energy efficiency will only partly offset the risks. Data centers' exposure to environmental restrictions, which is currently low, could increase as several countries across the world tighten regulations and local resources come under increased pressure. This could lead to long-term challenges, including increased scrutiny from regulators, investors, and other stakeholders over data centers' environmental effects.
Read More
- Private Credit Could Bridge The Infrastructure Funding Gap, Nov. 20, 2024
- Data Centers: Rapid Growth Creates Opportunities And Issues, Oct. 30, 2024
- Data Centers: Rapid Growth Will Test U.S. Tech Sector's Decarbonization Ambitions, Oct. 30, 2024
- Data Centers: Computing Risks And Opportunities For U.S. Real Estate, Oct. 22, 2024
- Data Centers: More Gas Will Be Needed To Feed U.S. Growth, Oct. 22, 2024
- Data Centers: Welcome Electricity Growth Will Fall Short Of U.S. Data Center Demand, Oct. 22, 2024
- Credit FAQ: Can Operators Navigate Pitfalls In Asia-Pacific's Data Center Boom?, Sept. 17, 2024
This report does not constitute a rating action.
| Primary Credit Analysts: | Pierre Georges, Paris + 33 14 420 6735; pierre.georges@spglobal.com |
| Sudeep K Kesh, New York + 1 (212) 438 7982; sudeep.kesh@spglobal.com |
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